Crazy Eduardos Retail: A process, internal control, and risk analysis of their sales recording accounting system

GROUP PROJECT # 4 HANDOUT

Crazy Eduardos Retail Inc., a public company, is a discount retailer of small home appliances and other electronic equipment. Merchandise is displayed in a showroom located in a small shopping center in Riverside. Customers browse through the merchandise at their leisure but must obtain help from a floor sales clerk if they wish to make a purchase. Basic Financial results are attached. Last year the following narrative description of the sales system was developed by an audit intern from UCLA who performed a system walk-through. She also found a flowchart prepared a few years ago before a POS system was implemented and a partially completed Audit Form 2009-173: Documentation of Internal Control Weaknesses and Implications. All documents are attached: Requirements The PIC for this client is most concerned with two material items in the F/S: Sales and A/R. The A/R balance is less material as the 2 credit account cards that are accepted clear the charged sales rapidly. Your audit team is being asked to prepare an internal control analysis of sales accounting processes including workpaper documentation and a report which describes and documents your work. The components of your report should include: An annotated version of the Crazy Eduardos narrative with appropriate legends which highlight: a. important Activities or Processes; b. Employees who are responsible for various activities; c. System Strengths (Internal Controls) and d. System Weaknesses, Risks or Threats 2. Annotated accounting system flowchart documentation [see Ch. 8, Fig. 8-6, plus research] which documents and describes audit-relevant control points [internal control strengths that mitigate important threats and may require audit I/C testing] and control weaknesses. 3. A business process map [see Ch. 6] indicating process data streams [as currently documented in the narrative and as would be expected in a computer-based sales recording system, see Fig. 8-9] and accounting impact of activities. 4. An analysis [ see Ch. 6, Ch. 7 , and Fig. 7-6] indicating the three most auditimportant PRs [list others which are audit relevant] and related potential audit implications [Ch. 6]. Describe/explain the potential audit implications of each PR. 1 1.

5.

An evaluation of internal control, including internal control over financial reporting. This should include a risk map [e.g. see Fig. 7-7], an analysis of control risk and audit planning [see Fig. 8-9 ] and a ICQ [ see Fig. 8-8] of unanswered questions that needs to be answered for us to complete our I/C evaluation.

Attachments found in prior or current workpapers. A1 :Sales Process Narrative.

Audit Form NAR2009-117 Prepared by: S. Hsu Date: 2/11/2012 Narrative of Crazy Eduardos Retail Sales Order System When a customer is ready to make a purchase, a floor clerk uses a POS register to key in information which creates and prints a four-part pre-numbered sales invoice [and sales order] for the customer. [An example of the sales document follows this narrative]. There are usually three to six floor clerks working at a given time and each has his or her own virtual book of sales invoices numbers. Each book contains 100 invoices that are sequentially numbered. The invoice numbers in one book begins where the preceding book ended. When a book is empty, the clerk notifies the store manager who is authorized to set the clerk up with a new book of invoices. The store manager is the only person authorized to set up books of unused invoices. At the end of a shift, a sales report is generated for each clerk. If a book still has invoices to be used, the computer automatically begins with that number when the clerk beings another shift. When inputting an invoice, for each item sold, the system provides an eight-digit item number (which has a two-digit check digit embedded in the sequence), a description of the item, and its price as posted on the display. For old customers, the system fills in customer data and the customer is asked to verify its accuracy. For new customers, the clerk inputs the customer name and address and the quantity desired for each item. The invoice has room for six items to be entered. Copy 3 of the invoice is given to the customer, who is then directed to the waiting/pickup area. The floor clerk keeps copy 4 of the invoice in a hard copy invoice book file. Copies 1 and 2 are placed in a plastic container which is sent to the storeroom/warehouse via a pneumatic tube. The storeroom/warehouse uses the invoice to select the merchandise and place it on a conveyor belt that takes it to the customer pickup area. Copy 1 is initialed by the storeroom clerk who prepares the merchandise. Copy 1 is then firmly attached to the merchandise before it is placed on the conveyor belt. Copy 2 of the invoice is used by a storeroom clerk to update perpetual inventory records. Copy 2 is then filed numerically in the storeroom. If the merchandise is not in stock, the storeroom manager calls the customer waiting area to inform the customer. In this case, both copy 1 and 2 of the invoice are stamped cancel not in stock and filed in the numerical file. There are usually three or four employees/cashiers in the customer pickup area. Cashiers are always supervised by a cashier supervisor. When merchandise comes off the conveyor belt, a cashier identifies the customer and uses Copy 1 of the invoice to ring up the sale on an electronic cash register. Each cashier is assigned to a specific register. The item number, quantity and price are taken off Copy 1 of the invoice and entered into the cash register. All sales must be paid for by cash, a debit card or by a Visa or Master Card credit card. The cashier retains Copy 1 of the invoice in the register drawer, and the customer keeps copy 3 plus a cash register receipt to indicate payment. At the end of the day, the copies of all the invoices that have accumulated in the drawer are sent to the accounting department where they are filed numerically. The cash register is tied into the central computer system, which automatically accumulates total sales, cash receipts, and credit sales. The computer posts these sales to the appropriate account and to the

inventory control account. When a cashier shift change occurs, a subtotal of cash sales, receipts and the register balance is run off by the cashier supervisor and compared to the cash in the till while the cashier is present. Discrepancies are noted and accumulated in a weekly report.

Example of Sales Order and Invoice from for Crazy Eduardos Retail
Customer Order Form NAME: ADDRESS: CITY ZIP CODE PAYMENT CASH ORDER FILLD BY: Sales Order & Invoice #

STATE PHONE M/C DATE Item Description

VISA

Catalog #

[Warehouse Use]

Quantity

Unit Price

Total Price

Subtotal Tax Total

All returns must have sales receipt, be in original shipping carton and packing. No returns after 10 days.

Sales Clerk
Prepare sales invoice with iventory information.

SI2 SI1 Sales Invoice

SI3 Sales Invoice

SI4 Sales Invoice

Customer

Maintained in invoice book and filed.

A1
To: Storeroom

A2
To: Pick-up Area

Flowchart [somewhat outdated] found in workpapers

Audit Form 2007-173: Documentation of Internal Control Weaknesses and Implications: Sales recording process. AF 2009-173 Prepared by: S. Simmons

Date: 3/5/2007

Client: Crazy Eduardos Retail Accounting Cycle: Sales and A/R 1. Control 2. WEAKNESS DESCRIPTION 3. AUDIT IMPLICATIONS Weakness ID The invoice books are not logged in Sales and income could be CW1 when the clerks returns the unissued understated. COGS could be invoice books. overstated. Prices should not be entered manually CW2 on sales invoices . There is no independent verification of items, quantity, or extension before invoice information is entered into the cash register.

CW3

Note : AF 2009-173 should be completed for each significant process with process

data streams that affect significant accounting transactions. Please key to numbered control weaknesses within narrative and flowchart documentation.

Basic Financial Results: Crazy Eduardo Retail

Crazy Eduardo Retail, Inc. Income statement 2009 2008 $ $ 262,268 194,371 67,897 31,370 12,405 820 3,210 26,512 13,268 13,244 $ $ 136,268 103,421 32,847 12,677 8,431 438 1,211 12,512 6,734 $ 5,778

Net Sales - C/G/S Gross Profit S, G & Admin. Facilities Depreciation Interest Exp.* Int. Income Inc. before tax Inc. Taxes Net Income

2010 Unaudited $ $352,523 272,255 80,268 45,273 16,568 5,233 7,403 20,597 10,001 $ 10,596

2010 Unaudited $ Current assets Cash Short Term Investments Accounts Receivable Allow. For Uncollectibles Receivables [net] Due from Affiliates Inventories Prepaid Expenses Total C/A Plant, Property & Equipment [net] Other assets Total assets Current Liabilities Accounts Payable Notes Payable Short Term Debt 9,347 121,957 11,931 1,085 10,846 109,072 10,639 261,861

Crazy Eduardo Retail Inc. Balance sheet 2009 2008 $ 16,652 26,840 2,471 225 2,246 59,864 2,363 107,965 $ 29,331 3,014 274 2,740 26,543 645 59,259

26,401 6,596 294,858

13,425 5,560 126,950

4,850 1,419 65,528

50,022 49,571

51,723 2,254

23,078 423

Unearned Revenue* Accrued Exp. Total C/L Long Term Debt Convertible Subordinated Debentures Unearned Revenue** Equity Common stock Paid-in Capital R/Earnings Total Equity Tot. Liab. & Equity

3,641 5,593 108,827 8,459 80,975 3,337 92,771 313 57,678 35,269 93,260 294,858

3,696 17,126 74,799 7,701 1,829 9,530 280 17,668 24,673 42,621 126,950

1,173 8,733 33,407 7,625 635 8,260 134 12,298 11,429 23,861 65,528